New tax laws on immovable property must be enforced for huge revenue generation: FBR report

Karachi: The real state sector has tremendous potential for revenue generation by incorporating capital gains on immovable property through the enactment of new tax laws with proper documentation and registration of sales/purchase of property and a dire need to reactivate the enforcement wing of Inland Revenue Service (IRS).
Many individuals and real state agencies are earning huge income from the property sector (real state/sale and purchase of immovable property) and this income is not being taxed at all as they cannot collect any tax over income due to the constitutional bar, said a research report of Federal Board of Revenue (FBR).
While the federation is not charging any tax over this income due to the presence of provision 37(5) (c) in the Income Tax Ordinance (ITO) 2001, Income Tax is a federal subject as per paragraph (a) clause (3) of article 160; in the fourth schedule of the constitution Entry No. 47 “Taxes on income other than agriculture income”. It means all incomes are chargeable to tax (including the gain/income derived from sale of immovable property the except agriculture income).
No single provision in the constitution clearly bars the federation from taxing this potential sector of property. Whereas, 18th Amendment has brought the drastic changes into the constitution of Pakistan with respect to taxation of property and so on. The main entry relevant with the taxation of property is the Entry No. 50 “Taxes on the capital value of assets, not including taxes on immovable property”.
In the past the Federal Board Revenue (FBR) used to tax the sale and purchase property by imposing the Capital Value Tax (CVT) at the rate of 4 percent. But, after the passage of 18th Amendment, the federation can no longer levy this tax but this power has been transferred to provinces.
There is a need to formulate a proper and practical mechanism to determine the cost of property at the time of acquisition of property and the marginal difference at the time of sale.
The tax rate should be rationalized with a purpose of taxing huge profits and must be fluctuating and increases with its profit margins however, there should be exemption in law for the small investors which could not harm the sector’s activity.
Moreover, it was also felt that real estate sector has emerged a significant variable of growth and investment yet its inherent potential of bringing in more revenue in the state exchequer through its effective taxation has not been realized. This is an effort to sensitize the policy makers to tap the immense potential of real estate sector by imposition of tax on capital gains on immovable property to generate additional revenues and keep the wheels of the state machinery moving.
Before the incidence of 9/11, the real estate in Pakistan was undervalued due to the flight of capital and the slump in business within the country.
The catastrophic events of 9/11 became one of the major turning points and had a direct impact on the flourishing of real estate in Pakistan. In 1999-200 Pakistan had foreign exchange reserves of 1.967 billion dollars. As of October 2004, the reserve position stood at 12.271 billion dollar.
The first phase erupted right after the 9/11 incident. A few months after the US incident, prices of the property started to rise. This happened only in the Karachi’s Defence Housing Society, Lahore’s Defence Housing Society and Gulberg, and Islamabad’s F-6, F-7, F-8 sectors, Blue Area and the Jinnah Super localities. The prices in other areas witnessed marginal increases.
Property in Islamabad saw a very sharp rise. Houses which were available for Rs5 million in 2000 and 2001 shot up to Rs30 million by mid 2003 in F-6, F-7 and F-8 sectors2. The smallest rise was in Karachi where houses worth Rs5 million went up to Rs12 million in the same period, this all had happened due to the increased insecurities of Pakistani expatriates in the United States.
Pakistan’s economy recorded a growth of 6.4 percent in 2003-04. This expansion was being fuelled by the easy availability of credit and the lax monetary policy.
In 2006 the bank interest rates dropped down to 5 percent from 18 percent (The National Savings).
Private sector credit off-take was at record and banks started to venture into home financing business. Reportedly, banks disbursed Rs8 billion for the housing sector but the amount of borrowed money that found its way into real estate purchases was far greater than that.
Variation in the rise among different localities of the same city is due to the fact that home buyers preferred new places of residence. Moreover, a lot of agricultural land was converted into housing schemes. The availability, closeness to the city, and town planning itself helped people toward buying and investing.
Changes in property prices can influence private consumption and investment through wealth and balance-sheet effects. They also affect consumer price inflation via both direct and indirect channels, and can have a significant effect on country’s competitiveness in international markets.
The importance of the real estate sector as a catalyst for growth can be gauged from the fact that it is the second largest employer next only to agriculture. This is because of the chain of backward and forward linkages that the sector has with the other sectors of the economy especially with the housing and construction sector. About 250 ancillary industries such as cement, steel brick timber and building materials are dependent on the real estate industry.
Poor farmers with small pieces of land in the villages close to the municipal limits could hardly make ends meet. But with the fast expansion of the city’s frontiers, they sold off their property, pocketing millions of rupees overnight.
Two months after 9/11, the forex reserves went up to 4bn dollar as Pakistan joined the US coalition against the “war on terror”. The forex reserves now stand at more than 12bn dollar.
Moreover there is little doubt that the catalyst for this growth has been the massive amount of remittances sent back by non-resident Pakistanis in the US and later from Europe. In 2001, the remittances totaled a little more than 1bn dollar. But since 2002, Pakistan has received nearly 4bn dollar in remittances every year. That means an additional inflow of 14-15bn dollar has been returned to the country since the 2001 attacks.
The wealth flowing in the country is second only to the boom created by money sent back to the country by its blue collar workers in the Middle East in the 1980s.
Banking sector also cashed into the boom and went into house financing big way. Due to increased liquidity banks had money to lend but found returns on loans low. This was because the loans taken against land were being reinvested into the property market.
Growth in the construction sector and banking sector were the major deriving forces in creating the demand for more labor, reducing unemployment rate substantially during the last decade. As a result the Gross Domestic Product per capita income increased during the period.
According to Finance Division of Government of Pakistan, GDP per capita income increased from 450 dollar in 1999 to 926 dollar in 2007 and 1085 dollar in 2008. GDP Purchasing Power Parity (PPP) also shows similar type of increase. In 1999 GDP PPP stood at 270 billion dollar which shoot up to 504.3 billion dollar in 2008. Poverty levels also came down, owing to backward and forward linkages of property boom, in the previous decade. It was reduced by the 10 percent from 34 percent in 1999 to 24 percent in 2007.
As India and Pakistan shared same history till 1947 and they are governed by the same act of 1922 income tax act till the date of independence. In fact India is levying taxes on capital gains however Pakistan exempted this sector from paying tax.
According to Capital Gain tax under Indian Income Tax Act 1962 Section 45 to 55A, deal with the capital gains. Section 45 of the Act, provides that any profits or gains arising from the transfer of a capital asset can be chargeable to income-tax under the head ”Capital Gains” and shall be deemed to be the income of the previous year in which the transfer took place. There are four requisites of a charge to income tax, of capital gains under section 45. Firstly “there must be a capital asset”. Secondly “the capital asset must have been transferred”. Thirdly “the transfer must have been affected in the previous year”. Fourthly “there must be a gain arising on such transfer of a capital asset”.
Gains on sale of capital assets held for more than three years are treated as long-term capital gains and are taxed at concessional rates compared short-term capital gains. While calculating taxable long-term capital gains, the cost of acquisition and the cost of improvement are linked to a cost inflation index. As a result, the indexed cost of acquisition is deducted from the sale consideration received, to arrive at the capital gain. Long-term capital gains are taxed at a flat rate of 20 percent for individuals and foreign companies, and 30 percent for domestic companies. Long-term capital gains on the transfer of shares/bonds issued in a foreign currency under a scheme notified by the Indian Government are taxed at 10 per cent.
However in Pakistan, gain arising from disposal of capital asset. Such income is chargeable to tax under the head capital gain u/s37 of income tax ordinance 2002.Capital gain can be calculated according to following procedure: disposal of capital assets within 12 months, disposal of assets after 12 months.
If the asset is disposed within 12 months its capital gain will be calculated by subtracting the cost of asset from the consideration received on disposal of assets. But if the assets are disposed off after 12 months then the amount of gain determined will be multiplied by ¾.
According to section 37(5) (c) of income tax ordinance 2001, the immovable property is exempted from taxation on any capital gain on it. Therefore, there is a need for the promulgation of new laws and amendments in already existing laws, rules and regulation.

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